January 28, 2022

JF2705: Beyond the Pandemic: Adapting Investment Strategies to the New Normal ft. John Chang

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We’re sharing the top ten sessions from the Best Ever Conference 2021 as we gear up for the Best Ever Conference 2022 at the Gaylord Rockies Convention Center in Colorado this February 24-26th.

In this episode, John Chang shares his top strategies for managing your investments during the pandemic, including how to navigate the economy, understanding the market changes, and what you should be aware of moving forward.

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Joe Fairless: Welcome to another special episode of The Best Real Estate Investing Advice Ever Show where we are sharing the top sessions from the Best Ever Conference 2021. This year, the Best Ever Conference is back in person, February 24th through 26th. Come join us in Denver, Colorado. You’ll hear all the new keynote speakers, you’ll meet some new business partners, you’ll learn some insights from the presentations and from the people you meet, that you can apply to your business today. Here is an example of a session from last year that is still relevant today and will be beneficial for you.

John Chang: I’m going to cover four things in my presentation today. I’m going to cover some information about the economy, some of the economic factors affecting our business, some of the top headlines we’re all seeing today, and give you an understanding what’s really going on behind those numbers, some of the leading real estate trends that investors are looking at, and some of the outlook performance there, as well as top strategies for the current climate.

I’m going to start in with kind of the key ingredient here, which is that the pandemic is the one big thing. It is causing a great deal of the issues that we’re facing as a business. Until we get the pandemic under control, the economy cannot heal. We’re already making significant headway into what’s happening with the vaccines; that, of course, is the key ingredient to driving forward economic recovery. But there’s still a lot of headwinds; we still are facing some challenges over the next six to nine months as we grapple with this global health crisis. We can see the light at the end of the tunnel, but it’s not there yet, we still have a ways to go, and that’s going to be something we’re battling with.

One other thing that we’re seeing as a major challenge has been jobs. We lost a record number of jobs, right as we came into the pandemic. We basically gave up 10 years of growth giving back 22 million jobs. As we came out of our lockdown, we got half of those jobs back, we got 12 million jobs back but it was really just not enough. We hit a point where it flattened out and we started losing momentum. That really weighed on the economy and our ability to move things forward. There are specific sectors that captured the worst of this. There is the restaurant industry, the hotel industry, and those areas are still in the process of recovering.

When we look at what happened with retail sales, they’ve been fragmented. Again, we went into this downturn, we got to bounce back as we got that stimulus, and we got those stimulus checks, and it helps support our economic growth. We actually grew, we hit a new high point last fall as people spend all that stimulus money and unemployment benefits. But as the Cares Act burned off, we can see that we started giving that back and that happened with the jobs. We got that bounce, then it started slowing down, and then we started losing jobs again. Again, there are specific sectors that are being impacted far worse than anything else. That’s again, restaurants and bars, apparel industry, electronic sales, all being hit very hard. Whereas there’s other parts of the sector of the economy like home repairs and internet sales that have hit an all-time high. We’re seeing different parts of the economy perform differently. Depending on what happens with the vaccine, the timeline to recovery could vary. But I do need to point out that once we get through this, once we get to the back side of distributing the vaccines, once we hit that herd immunity or that critical mass, we start to see a couple of new things come into play.

First of all, the amount of money in money market mutual funds hit a new peak over the last few months. It’s come down a little bit since then and the amount of money that people have put into savings over this cycle is 2.8 trillion greater than normal, what I would call normal. Because if you look back historically, basically this number doesn’t change a whole lot until the pandemic. We have all of this money sitting on the sidelines and it has the potential to come back into the economy very, very quickly after we get to a vaccination. Sometime in the second half, we could see this wave of money, four and a half trillion dollars start to come back into the economy. We’ve already had $2.2 trillion put in with the Cares Act, we had another 900 billion added to the economy through the second round of stimulus. Well, this is what could be the fourth round… We may have a third round of stimulus coming out shortly. This could be a fourth round, four and a half trillion dollars in cash flowing back into the economy. That’s why many economists have raised their forecasts for 2021. Right now, the baseline is right around 5% expectation of growth, which is fantastic. We haven’t hit that number in 30 something years for an annual rate of growth.

Break: [00:05:49][00:07:28]

John Chang: On top of that you could see some huge gains. Morgan Stanley is at the top of the pack. They’re saying, “Hey, we’re expecting 2021 to have 7.6% growth.” A lot of other economists are saying 6.5 or 6% growth and everything in between, it really doesn’t matter. If we break 5%, we haven’t done that in forever, that’s going to be huge, that’s going to drive our economy forward, that’s going to be a key ingredient to our success. Now one of the other things that, as I was preparing this, I saw so many baits happening online, in the news, and arguments. I look at so many of these things and I just shake my head because I don’t know where people get this information. It doesn’t make any sense to me. I want to dispel some of these top myths that I see all the time.

The first one is that there is this huge wave of evictions coming, that as soon as these restrictions on evictions burn off, as soon as we get to the other side of this, and all these, evil landlords are getting ready to kick all of their tenants out because they have been paid. But the reality is far different from that. What we’re seeing across the media is that rent collections are actually far better than people expected. Things are actually going relatively well. Yes, they’re down. If you look at the graphic there in the bottom left, you can see that the spread between those two lines has widened up. That’s because the first package of stimulus was burning off and the second round hadn’t started in yet. People’s unemployment benefits were burning off, people didn’t have cash anymore, they burned through their savings, and their ability to cover their payments was becoming a challenge. So yes, rent collections have tapered a little bit, the spread. I compare it between 2019 versus 2020. The news always talks about “Oh, rent collections are only 90% or 85%, or whatever it is.”

But you have to compare it to 2019, what’s our normal behavior, and that’s where I’m drying up that spread. It varies by class, it’s those bars in the top left hand corner of the slide. If you look at the map, you can also see it varies dramatically by metro. It’s hard to remember this. We’re all living within the context of our own little world. If you live in the Northeast right now, you’re thinking about snow. I’m in Phoenix right now and I’m looking out and it’s sunny and 80. There’s your own reality within this and that’s true with the pandemic, when you look if the experience of somebody in San Francisco is entirely different from the experience of somebody in Dallas. You have to look at what are the rent collections doing in different cities across the country? How are they performing? What about my asset class? What are the experiences there? But I can say that the numbers tossed around in the headlines are not going to materialize. They’re exaggerating this to capture the headlines.

The next big topic I see all the time is this wave of distress, that there’s this huge, huge issue with investors ability to pay for their properties, and you see these distressed numbers, and that there’s going to be foreclosures, and there’s literally hundreds and hundreds of billions of dollars in distressed funds, targeting assets that are going to come to market when the owners can’t pay. Now, this has been a very severe recession, we fell into a very, very, very big hole economically, and we’ve had those challenges. But we are definitely not seeing a massive wave of distressed sales. In fact, distressed sales are only about 1% of the total right now, and I don’t expect a huge wave to come afterwards. When you look at the CMBS loans, that’s those bars on the right, and compare it the peak of the financial crisis against the current situation. Industrial,1.3% of industrial loans are 60 days late, 2.5% of apartment loans. These numbers are well below anything that anybody would call a distressed market. Of course, if you look at retail and you look at hotels, yes, there are a lot more late payments, particularly in CMBS.

But I can say with CMBS, the number that gets thrown around all the time because that’s a number everyone has, only tracks CMBS loans. Well, the CMBS lenders were the ones who were not given forbearance. They’re the ones who have the most late notifications. If you look at local banks which are the biggest lender right now, they have very little loans that are late because they are partnering with their investors and helping them get through this. This is why your lender becomes such an important part of your team as you’re going out and looking at how do you acquire assets. Lenders are a critical part of that and they are a team member just like everybody else. Make sure you have the right lender, make sure you understand the types of lending that you’re going to be using. They have different strengths and weaknesses and are applied to different parts of business.

When you look at the other big one was that this is the death of retail. I’ve been listening to this for the last five to 10 years, it’s not true. There are parts of retail that are going to be impacted. When you look at year-by-year vacancy rate change of different types of retail centers against other types of investments, like apartments and industrial properties, actually the movement in vacancy rates has been comparable for the most part. Now you got those old shopping malls out there. Yes, absolutely, they’re a problem, they’re not going to be fixed soon. That’s where a big chunk of that vacancy rate is coming from and that’s where you’re going to see challenges. Those are really redevelopment projects. But when you look at your neighborhood and community centers, I’ve been working with investors a lot on those lately, those neighborhood centers with a grocery store and a lot of necessity retailers are great, they’re doing very well.

The next thing is that the rent collections at retail actually almost fully recovered a huge portion of the spectrum. If you look on the right side of this graph, you can see that there are sectors that face headwinds. Things like health clubs, and entertainment venues, restaurants, not all paying, that’s where you’re going to see problems. But if you’ve got a bank, a grocery store, a pharmacy, and a home improvement store in your retail center, you’re doing great. You got to look underneath the surface, when you see things in the media, don’t take it at face value.

Shifting over to some of the key trends and what we’re seeing there. We look at the apartment supply and demand trends. The net absorption has actually been holding up very well, but we are facing record levels of construction. When you look at the right hand graph here, you can see the class A vacancy rate is coming up very dramatically, the class B and class C are pretty stable. In fact, darn near record low vacancy rates. Those are doing very well but we are seeing record levels of construction in 2020 and we will see about the same level of construction in 2021. But then it’s going to taper and it’s going to taper for all property types, the pace of construction. First of all, because of the pandemic and the construction pipeline, but second of all, because the cost of building materials are at a record high as well. That’s lumber, that’s concrete, that’s copper, that’s all the things you’re putting into a building are really at an elevated price point right now, and that makes it difficult for builders to get a project to pencil.

The next thing I want to talk a little bit about is self-storage. Again, as we went into the pandemic, a lot of the self-storage investors were cutting their rates and saying, “Oh, man, we’re going to be in for some tough times.” It actually turned out not to be a tough time for self-storage. In fact, the national occupancy rate in self-storage hit an all-time high in the third quarter of last year, which is our most recent data. We’re seeing some really strong momentum behind self-storage. Yes, there has been a lot of construction over the last few years but that’s also starting to burn off and come back. We could see a new wave of construction in 2022, I don’t know yet, it’s speculative. But one thing about builders is that when they see something hit a record high occupancy rate, they want to go ruin that for everyone. So, there you go.

Break: [00:15:52][00:18:48]

John Chang: The next thing, I’m going to touch on all these other different property types very briefly. As I mentioned, retail doing better than most people expect, vacancy rate up to about 5.6%, and it’s going to continue to climb this year. I think there’s a lot of dark space out there that hasn’t been captured in that number yet. When you look at office, basically leasing activity is on hold. There’s a lot of uncertainty, people don’t know if they’re going to come back after the vaccine or not, but it is still unknown. We’d had this terrible negative absorption because nobody was leasing anything so vacancy shot up. We’re not at a peak yet, we could reach a peak in 2021 but it’s still unknown. Then industrial, which everybody is loving right now, is going to continue to outperform. But there is always the construction wave on that one as well.

I’m going to talk a little bit about some of the key strategies as we move toward a wrap up here. We’re navigating what has turned out to be this massive black swan event and has significantly impacted our business. We all had plans, right? Two years ago, a year ago, we all had plans of what we were going to be doing, where we’re going to go, how we were going to invest. Everybody has a great plan until they get punched in the mouth according to Mike Tyson, and I think he has pretty good knowledge of that. Basically, we were humming along the first two months of 2020, commercial real estate sales were doing great, and then this pandemic hit, the sales activity collapsed going into the second quarter. It’s been kind of on this recovery cycle since then and we are generating a lot of momentum. We are starting to get back to close to normal. We’re not going to get back to normal for a while yet, the vaccine is a key ingredient. Like I said, there are real questions about certain parts of our industry, about certain types of real estate that are going to restrain those as we go forward.

The next one, Wayne Gretzky, “Skate to where the puck is going not where it’s been,” fantastic advice. I’m going to tell you a little bit about where the puck is going right now. When you look at demographics… Actually, I shared this slide two years ago before we hit a pandemic and before any of that was happening. I said, “Look, there’s this wave of young people, there’s this huge generational wave of millennials out there. They’re in a prime spot from a renter standpoint, but they’re moving towards tipping points on other items. They’re looking at getting married.” Now, two years later, the peak of this wave has moved in. 60% of millennials are age 30 and older, a larger and larger share of them are getting married, a big piece of them are moving into that first time home purchase. We saw this wave of home purchases that were sparked by the pandemic, that was momentum that was already moving. We’re just catching up with it, it’s just catching up to the news.

We’re seeing this tremendous wave of people moving out of New York, moving out of the Bay Area, moving out of the Northeast in general, and they’re going south. Again, two years ago, actually, five years ago, we were already talking about this trend as we mapped out the demographics and lifestyle changes. People move to the suburbs, they move to smaller cities when they get older, and they’re moving out of that early phase of career growth. That was driving our urbanization. The pandemic has accelerated this movement and pushed a shift to the south. We have tailwinds and a lot of southern US cities, and we have headwinds in the Northeast and in California. This is not entirely pandemic-driven, this is mostly demographics-driven. As you can see here, when you look at the suburban versus the urban, and I have both apartment vacancy rates, and office vacancy rates up on the screen here. You can see just this dramatic shift in vacancies in the urban core.

Now a big piece of this is new construction, right? Because two years ago, builders are still working on a business plan they developed five years ago and they were plowing new development into the urban core. Now, we shifted and we shifted fast. We had a transition point early in the pandemic where people could work from home, they left and they move out to the suburbs. You can see that the suburban vacancy rate, it went up too, a little bit because of construction, but not nearly as severely as the urban core. Because people don’t need to be downtown anymore to work at their job. We’re seeing a similar trend, although not as significant with office space, we’re seeing the demand for suburban office space gets stronger, and the demand for urban office space get weaker. But again, that trend is still materializing. There’s a lot of uncertainty whether people will go back to the office and what that will look like when they do.

Finally, my third big piece of advice comes from Tom Brady. His statement is “I don’t care about three years ago, I don’t care about two years ago, I don’t care about last year, the only thing I care about is this week.” I’m not sure when he said it, but I don’t think it was just before the Super Bowl as a Buccaneer. I think that this is something he’s been saying and living for a very long time. I was thinking about what’s happening with investments and where people are focusing. What happens so often is an investor buys an asset in 2018 or 2019 and they have a plan for where that’s going to go. Well, the world changed. When the world changes, you have to adapt your strategy. Don’t stick to the plan you made two years ago. It may be a great plan, it may still work, but don’t simply stick to your guns because you think you need to. You can always adapt, you can move capital out of one asset and put it into something else.

When you look at the yields today and the spread over the cost of capital, it is about as wide as it’s ever been. Right now, because the lending climate is so strong, because the lending rates is so low, that investors have a window of opportunity to acquire assets. I don’t want to spoil it but we have a debate later today focusing in on where the interest rates are going. I have a personal opinion on that that I’m going to share today, as well as the four other fantastic speakers. I’m not going to spoil it. But I think that this window we’re in today, with very low interest rates and stable cap rates, it really is something people should be considering as they make their investment decisions. Don’t fall in love with the assets you bought two years ago or three years ago, you need to remember this is about return on investment. If you need to reset your strategy like Tom Brady, then you should do that.

Joe Fairless: Well, I hope you gained some useful insights and actionable advice from this previous Best Ever Conference session. Remember, if you’re looking to scale your investing in 2022, we look forward to seeing you in Denver. Get 15% off right now with code BEC15 at besteverconference.com. That is code BEC15 for 15% off at besteverconference.com.

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